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Black-Scholes Option Pricing: Implementing a Hands-On Assignment Using

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JOURNAL OF ECONOMICS AND FINANCE EDUCATION  Volume 14  Number 1  Summer 2015

Black-Scholes Option Pricing: Implementing a

Hands-On Assignment Using Excel
Christi Wann1
ABSTRACT

Demonstrating the complete Black-Scholes option pricing formula in a

traditional classroom setting presents several challenges due to its complex
nature. Therefore, there are several educational benefits to requiring an
interactive Excel assignment that engages students in formula programming
to observe instantaneous price changes in calls and puts. Students gain job-
transferable Excel skills and learn how the major components of the option
pricing formula affect the resulting option price. Additionally, the educator
benefits from the introduction of a simple macro function that expedites
grading complex formulas.

Key Words: Black-Scholes Option Pricing, Finance Education, Computer Modeling

Introduction

The option pricing formula derived by Black and Scholes (1976) and Merton (1973) is an arduous formula
for students to calculate. The act of calculating the European-style option value takes a significant portion of
class time and leaves students overwhelmed. Therefore, it is often difficult students to absorb the relationship
between option prices and the six major determinants of option values without going through lengthy example
calculations. For example, an educator informs students that ceteris paribus, when the dividend yield is greater,
then the call option value is lower. Most likely, students will memorize rather than interact with this
information.
This paper proposes an Excel-based assignment that results in three primary benefits to students and the
educator. First, student learning is reinforced by requiring the use of Excel to input the Black-Scholes option
pricing formula through cell referencing (Black and Scholes, 1976). This allows individual hard-coded variables
to be changed so that students instantly see the new option value. Further, students are required to utilize data
tables to observe how changes in the six major determinants of option values affect call and put prices. Second,
this assignment forces students to gain meaningful experience in Excel which enhances their job market “hard
skills.” Third, the educator can facilitate grading by creating a simple macro function that reveals specific cell
formulas created by each student. This macro function enables the instructor to quickly determine if a student
receives credit or does not receive credit. A student receives credit for correctly completing the individual
formulas to obtain the numerical answers. The function will inform the educator when a student should not
receive credit due to a hard-coded numerical answer that lacks the required formula. The numerical answer
could be obtained from other students who already successfully answered the question during class.

Motivation

The major motivation for this particular teaching method is two-fold. The catalyst for this teaching tool
came out of a discussion with students. Students in an Investments I course requested assignments that would
require Excel in the subsequent course in order to graduate with relevant job skills. Holden and Womack (2000)
express that it “is probably safe to say that there is no finance function in a post-college job in the year 2000 that
does not use a spreadsheet like Excel regularly.” According to the New York Times (Browning, 2013), highly

1
Department of Finance, University of Tennessee at Chattanooga

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qualified graduates who have obtained impressive jobs on Wall Street lack “nuts-and-bolts skills like
spreadsheet building…which are not part of university curriculums.” Firms such as Goldman Sachs and the
Blackstone Group send new hires to take courses in Excel modeling and financial analysis from Training the
Street and Wall Street Prep at an expense that can exceed $1,000 per day (Browning, 2013). And,
undergraduate students with an extra $3,000 can take a four-day Undergraduate Wall Street Boot Camp in New
York that teaches basic financial modeling, valuation and analysis (Browning, 2013). Many of these basic skills
can be incorporated in many college finance courses at no additional cost to the student.
A second and equally important motivation for this spreadsheet-based assignment is that Excel enhances
concept retention as an alternative, more engaging learning opportunity. This idea is consistent with the
“constructivist” learning approach where knowledge is acquired, or “constructed,” by spreadsheet modeling
which leads to feelings of empowerment and user control (Boethel and Dimock, 1999; Maddux, Johnson, and
Willis, 1997). Hess (2005) advocates the “hands-on” use of spreadsheet modeling in the classroom to enhance
understanding, retention, and employability. Further, surveys report that finance faculty and business schools
are urged to use more technology in the classroom by the business community to prepare students for the
workforce (Bailey and Heck, 2002; Gitman and Vandenberg, 2003).
Excel assignments are currently required for all calculation-based chapters taught in Investments II during
designated class periods held in a computer lab. The feedback from students reflects that they understand the
classroom lectures better after completing the Excel assignments. Students initially behave in a frustrated
manner, then become ecstatic when the correct answer is obtained. Additionally, students appear more
confident and empowered after completing their most recent Excel assignment. This effect is consistent with a
small sample survey of students assigned an excel-based finance problem which found increased feelings of
self-actualization and self-competence (Ghani and D’Mello, 1993).
The creation of Excel assignments is warranted, however there is a legitimate concern as to verifying
individual student completion of each assignment. Although instructors typically oversee lab assignments, it is
necessary to obtain proof that a student did not hard code an answer by consulting a friend instead of manually
typing the complex formulas. Excel does not have a function that extracts the formulas contained in a cell.
Therefore, a simple macro was written to replicate the needed formula. A separate “Print” tab for the Excel
assignment contains three columns. The columns contain a list of each question’s cell formula, the student’s
numerical answer from the same cell, and the correct numerical answer. The correct numerical answer column
is displayed so that students can check their answers as they work through the assignment. This method appears
to give students confidence as they obtain correct answers.

Spreadsheet Construction

This paper presents a portion of a spreadsheet assignment that models the Black-Scholes option pricing
formulas for calls and puts (Black and Scholes, 1976). The traditional classroom lecture includes a discussion of
the binomial option pricing model, the Black-Scholes option pricing model, the Put-call parity theorem, and
arbitrage opportunities (Bodie, Kane, and Marcus, 2013). The author created an Excel assignment for each of
these topics, however the Black-Scholes model is the focus of the chapter and offers many benefits for students
as a required Excel assignment.
The Excel spreadsheet is structured according to the Black-Scholes option pricing model (Black and
Scholes, 1976) with an adjustment for dividend-paying stocks. The value of a call option is equal to

𝐶0 = 𝑆0 𝑒 −𝛿𝑇 𝑁(𝑑1 ) − 𝑋(𝑒 −𝑟𝑇 )𝑁(𝑑2 )

𝑆 𝜎2
ln ( ) + (𝑟 − 𝛿 + )𝑇
𝑑1 = 𝑋 2
𝜎√𝑇

𝑑2 = 𝑑1 − 𝜎√𝑇

and the value of the put option is equal to

𝑃0 = 𝑋(𝑒 −𝑟𝑇 )[1 − 𝑁(𝑑2 )] − 𝑆0 𝑒 −𝛿𝑇 [1 − 𝑁(𝑑1 )]

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Where:

C0 = Theoretical call value

S0 = Current stock price
e = Base of the natural log
 = Annual dividend yield on the stock
T = Time until expiration in years
N(d) = Probability that a random draw from a normal distribution will be less than d
X = Exercise price
r = Risk-free interest rate (annualized)
 = Annual standard deviation of continuously compounded stock returns
P0 = Theoretical put value

Call and put option calculations are first calculated by students during a pencil and paper assignment in
order to learn the mechanics of the formula before completing the Excel assignment. The answer key
spreadsheet should be constructed by the educator before the student assignment spreadsheet is created. Exhibit
1 shows the first portion of the Excel answer key.

Exhibit 1. Call and Put Option Values Assignment Key

Students must take the numerical data from the question and type the data in the designated yellow-shaded
cells. Question 1 asks for the value of the call option. Students must solve for parts “1.a” through “1.f” before
solving the Final Answer, “1.g.” The Black-Scholes option pricing formula was divided into parts “1.a” to “1.g”
due to its complexity. The parts also allow the educator to quickly pinpoint a cell where a referencing or syntax
error has occurred. All yellow-shaded areas must have formulas that consist of cell references to the hard-coded
numerical data. This requirement allows the Final Answer, “1.g,” to dynamically change if the student desires to
see the effect of altering the original data assumptions. The answer to question “2.a,” the value of the put
option, is calculated by cell-referencing the hard-coded numerical data, N(d1), and N(d2). Again, this allows
students to see the effect of changing the original data assumptions on the put option value, “2.a.”
The next purpose of the assignment is that students generate the implied relationships of the determinants of
call and put option values in Excel. The following determinants of call and put option values are discussed in

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the course’s required textbook, Essentials of Investments (Bodie, Kane, & Marcus, 2013). All else equal, as the
value of the stock price increases, the call (put) option value increases (decreases). As the value of the exercise
price increases, the call (put) option value decreases (increases). Higher standard deviation and longer time to
expiration increase call and put option values. As interest rates increase, the right to buy (sell) at a fixed price in
the future becomes more (less) valuable due to time value of money effects. Higher levels of dividend payouts
reduce capital gain potential. Therefore, call option values are reduced while put option values are increased.
These relationships are summarized in Table 1.

Table 1. Determinants of Call and Put Option Values

All else equal, if this Then the value of Then the value of
variable is larger the call option is the put option is
Stock Price Larger Smaller
Exercise Price Smaller Larger
Standard Deviation Larger Larger
Time to Expiration Larger Larger
Risk-free rate Larger Smaller
Dividend Yield Smaller Larger

The second portion of the answer key spreadsheet contains data tables for each of the six determinants of
call and put option values. Therefore, there are six call and six put data tables that will allow the student to
observe relationships described in Table 1. Additionally, graphs are created for each determinant that display
both of the effects on call and put values. The following three screenshots in Exhibits 2, 3, and 4 illustrate the
data tables and graphs which represent questions three through fourteen. The Excel data table feature is found
on the “Data” tab under the “What-If Analysis” drop down menu. Since only column information varies per
table, the “column input” choice is used within the data table feature.

Exhibit 2. Call Price and Put Price Relationships with the Stock Price and Risk-free Rate

Exhibit 3. Call Price and Put Price Relationships with the Standard Deviation and Strike Price

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Exhibit 4. Call Price and Put Price Relationships with the Time to Expiration and Dividend Yield

The next step involves creating a simple macro function that shows specific cell formulas for grading
purposes. A quick Google search for the keywords “Convert formula to text string with VBA” will lead you to
example VBA code for Excel (ExtendOffice, 2014). In Excel, go to the Developer tab and click on View Code.
A new window titled, Microsoft Visual Basic for Applications will appear. From the top line, click on Insert
and choose Module. Then, copy and paste the following code from Exhibit 5 into the new white box in the
middle of the screen.

Exhibit 5. Excel Macro Code to Create the Function “CellFormula”

Function CellFormula(Rng As Range) As String

CellFormula = Rng.Formula
End Function

Click the save button and close this window. Also, click the save button in the original file and a prompt to
save the file as a macro-enabled file with the “.xlsm” extension will arise. Save the file as a macro-enabled file

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with the “.xlsm” extension. Each time the educator and students open the file, the “Enable Macros” button at the
top of the screen must be clicked. Otherwise, the “CellFormula” function will not work. If a student mistakenly
works in the file without enabling the macros, the student should save and close the file. Next, the student
should reopen the file and enable the macros. The student should not lose any previously completed work in the
file.
The next phase for the educator is to implement the new “CellFormula” function in a newly created tab
within the Excel file. This tab, which the author labeled “Answers Only,” is still part of the answer key Excel
file. The following screenshot in Exhibit 6 shows the correct way to use the newly created “CellFormula”
function. Notice that across each row in Column B and Column C of the answer key the same cell reference
such as “$F16” is used. However, the function used in Column B is “CellFormula” in Column C just the
numerical value of the cell is referenced. In Exhibit 6, note that the author labeled the Answer Key Tab, “Ch.
16 Toolkit ANSWERS.”

Exhibit 6. Demonstration of “CellFormula” References in Answer Key Tab

Exhibit 7 shows the results of using the “CellFormula” function and the simple cell reference to the
numerical answer. Keep in mind, this is the answer key. In the student Excel assignment, there are only two
tabs. There is a tab for completing the assignment and a “Print” tab. The “Print” tab shows the results of the
“CellFormula” function, the student’s answer, and the correct answer in columns B, C, and D, respectively. The
“Print” tab is the only item needed by the educator for grading purposes.

Exhibit 7. “CellFormula” Function Results in Answer Key Tab

Exhibit 8 shows what a correctly completed Excel assignment should look like. When reviewing this printed
page for grading, only two things need to be checked. First, check that each answer contains a formula without
hard-coded answers. For example, a student that did not enter the functions but knew the correct numerical
answer could have typed “$2.09” in the “FINAL ANSWER” box on the main Excel worksheet. The educator
would see “$2.09” in column in B, C, and D. This student would not receive credit for this question because the
calculation was not performed. Second, check that the Student Answer value equals the Answer Key value. The

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JOURNAL OF ECONOMICS AND FINANCE EDUCATION  Volume 14  Number 1  Summer 2015

educator does not need to check the intricacies of the entire formula because if the numerical answer in Column
C is correct and there is a formula in Column B, then the formula is correct by default. Again, the answer in
Column C is the numerical value that the formula in Column B produced. Note that some cells do have “365” or
“1” hard-coded. This is fine, as these numbers are an inherent part of the Black-Scholes formula. It did not seem
necessary to create additional cells that contained “365” and “1” just for the sake of additional cell referencing.

Exhibit 8. Sample Portion of Student “Print” Tab Results Graded by Instructor

Exhibit 8 reveals that there are four Excel functions that students are required to learn and utilize. First, the
“LN” function returns the natural logarithm of a number. This function is required when calculating d1 from the
Black-Scholes equation (Black and Scholes, 1976). Second, the “NORM.S.DIST” function returns the standard
normal distribution value. Since the Black-Scholes formula for N(d1) requires the cumulative distribution value,
the formula contains the qualifier labeled “TRUE” (Black and Scholes, 1976). Third, the “EXP” function
produces “e”, the mathematical constant that is the base of the natural logarithm, raised to the power of a given
number. This function is required in the final calculation of call and put option values. Fourth, the function
“TABLE” represents the data table calculation available on the “Data” tab under the “What-If Analysis” drop-
down menu. Questions 3 and 4 are data tables that show how changes in the variable “Stock Price” affect the
call and put option values. The values of the variable “Stock Price” are presented to the student in a column.
Therefore, the “column input” choice is used within the data table function. This results in the formula
“=TABLE(,F8)” where the comma comes before the original cell containing the Stock Price.
The student assignment is structured like the answer key shown in Exhibits 1 through 4. The answers in the
yellow-shaded and green-shaded input cells are cleared. Exhibit 9 shows an example portion of the file received
by the student during a lab assignment.

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Exhibit 9. Sample Portion of Student Excel Assignment

Conclusion

This paper demonstrates how educators can create an Excel-based Black-Scholes option pricing assignment
(Black and Scholes, 1976). This particular teaching method contains several benefits for both students and the
instructor. Students obtain enhanced comprehension of the major determinants of call and put option values.
Further, students gain valuable hard skills and much needed experience in Excel. The educator is equipped to
use a simple macro that helps with grading a complex assignment. This macro can be extended for use in any
Excel-based assignment where lengthy or complex formulas are involved. The Excel file exhibited in this article
may be requested by contacting the author.

REFERENCES

Bailey, Barrie A. and Heck, Jean L. 2002. “Finance Faculty Perceptions of Business Schools’ Preparation for
the Technological Revolution.” Journal of Financial Education 28: 41-52.

Black, Fisher, and Myron Scholes. 1973. “The Pricing of Options and Corporate Liabilities.” Journal of
Political Economy 81: 637-659.

Bodie, Zvi, Alex Kane, and Alan J. Marcus. 2013. Essentials of Investments (9th ed.). New York: McGraw-Hill.

Boethel, Martha, and K. Victoria Dimock. 1999. Constructing Knowledge with Technology: A Review of the
Literature. Austin, Texas: Southwest Educational Development Laboratory.

Browning, Lynnley. May 30, 2013. Wall Street Turns to ‘Boot Camps’ to Train New Workers. The New York
Times. Retrieved June 25, 2014 from http://dealbook.nytimes.com/2013/05/30/wall-street-turns-to-boot-camps-
to-bring-new-workers-up-to-speed/?_php=true&_type=blogs&_r=0

ExtendOffice. 2014. “How to convert formula to text string in Excel?” Retrieved April 2, 2014 from
http://www.extendoffice.com/documents/excel/822-excel-convert-formula-to-text-string.html

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Ghani, J. A., and J. P. D’Mello. 1993. “Spreadsheets in Financial Education: Balancing the Challenges.”
Financial Practice & Education, 3: 65-71.

Gitman, Lawrence and Pieter A. Vandenberg. 2003. “The Future of Corporate Finance: A Survey of
Practitioner and Academic Opinions.” Journal of Financial Education 29: 23-42.

Hess, Kurt. 2005. “Spreadsheet-Based Modeling for Teaching Finance and Accounting Courses.” Available at
SSRN: http://ssrn.com/abstract=378680 or http://dx.doi.org/10.2139/ssrn.378680

Holden, Craig W., and Kent L. Womack. 2000. “Spreadsheet Modeling in Finance and Investment Courses.”
FEN Educator, Vol. 5 No. 5. Also available at SSRN: http://ssrn.com/abstract=241708

Maddux, C. D., D. L. Johnson, and J. W. Willis. 1997. Educational Computing: Learning with Tomorrow’s
Technologies (2nd ed.). Boston: Allyn and Bacon.

Merton, Robert C. 1973. “Theory of Rational Option Pricing.” Bell Journal of Economics and Management
Science 4: 141-183.

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